Study: label litigation has produced an innovation “wasteland”

Former music startup founders charge that the labels "suck companies dry."

Everyone knows the story of Napster, the peer-to-peer file-sharing service that was shut down by the major labels a decade ago. The destruction of Napster pushed peer-to-peer file sharing underground, leading to the rise of Grokster, the Pirate Bay, Megaupload, and dozens of other services that facilitate illicit file sharing. It may also have created a larger market for licensed services such as iTunes.

But a new Google-funded study argues that the destruction of Napster and the litigation campaign that followed it had deeper and more far-reaching implications than is commonly appreciated. The author, Rutgers-Camden law professor Michael Carrier, conducted interviews with dozens of senior executives who were working at music labels, venture capital firms, and music-related startups during the Napster era.

Many of them argued that the labels' aggressive litigation campaign against Napster and other early music startups created a venture capital "wasteland," with music-related startups unable to raise money. The result, Carrier concludes, has been a stunted pace of innovation that continues to this day.

The Recording Industry Association of American disputed Carrier's findings. "The fundamental mistake that this study, and other pieces like it, make is to assume that the only type innovation is technological," the organization said. The firms the labels sued a decade ago were "not innocent 'innovators,'" the group wrote. "Most unlicensed p2p services were very well aware that what they were doing was probably illegal, and they were deliberately architecting their software to be able to avoid knowledge."

A scorched-earth campaign

The emergence of Napster was a shock for the major labels, which had grown fat on two decades of rapid growth in CD sales. Many of them "saw the Internet as a fad." So it was a rude awakening to discover that millions of their former customers suddenly had the ability to share label music with one another at negligible cost.

The labels responded harshly, suing Napster and eventually driving the firm into bankruptcy. And Napster wasn't the only target. Around the same time, the labels also sued cloud music pioneer MP3.com. It would sue numerous music startups during the aughts.

Defending against copyright litigation can be tremendously expensive. Two people told Carrier that defending a lawsuit by a major label cost $150,000 to $200,000 per month. That's enough money that many startups would go bankrupt even if they ultimately prevailed in court.

And the intimidation tactics reportedly went beyond suing startups. The labels also threatened to file personal lawsuits against the officers and major investors of music startups.

"They suck companies dry"

The executives Carrier talked to said the labels made life miserable even for startups that tried to follow the rules.

One executive tells of a startup with millions of users that was sued by the labels. The firm told the labels "You guys made your point; we will charge anything you want to charge, and you can take any percentage you want to take." But the labels reportedly responded, "No, we want you to turn it off."

Indeed, some respondents charged that the labels treated lawsuits against music startups as a short-term revenue source. The labels "sat in meetings with digital startups and tried to take as much money as they could. They knew their business model was not going to work, that this was not recurrent revenue." But bleeding music startups dry helped the labels hit their quarterly revenue targets.

A venture capitalist reported that the labels insisted on signing short-term deals, one or two years at a time, that could be renegotiated if the startup was more profitable than expected. "As soon as the companies are profitable, they suck companies dry," the VC said.

CD protectionism

This seems short-sighted. Online piracy wasn't going away, and the failure to provide consumers with access to the music they wanted in convenient online formats surely drove some customers over to the dark side. So why did the labels pursue such an aggressive strategy?

One factor was the adamant opposition of brick-and-mortar retailers to online distribution. At the time that Napster burst onto the scene, retailers like Walmart and Tower Records were the labels' primary revenue source. Indeed, some interviewees argued that the labels treated these retailers, not individual fans, as their primary customers. Major retailers had substantial leverage over record labels because they decided whose products would be prominently featured in stores. And they insisted that music not be made available online at prices that would undercut the market for CDs.

The labels were also reluctant to undercut the market for physical CDs because they had billions of dollars invested in infrastructure for creating and distributing CDs. One label reportedly "spent a billion dollars on trucks to distribute their CDs." That investment would be wasted if the industry shifted toward low-cost digital downloads.

The labels' obsession with preserving the market for CDs led to unrealistic expectations for digital services. For example, before iTunes established the 99-cent price point for music singles, one label was "adamant" that "the single should be priced at $3.25." That was high enough that a customer who bought "two or three" singles would replace the revenue from selling a full album.

Carrier also charges that the labels were excessively focused on short-term profits. Executives' bonuses were based on quarterly profits. Nobody got a bonus for making a long-term investment that wouldn't pay off for a few years. Hence, they were more inclined to view the startups they were negotiating with as short-term sources of cash rather than long-term business partners.

The RIAA responds

The RIAA is not impressed with Carrier's study, and the organization shared with Ars a draft of a forthcoming response. It characterizes it as "wild speculation based on various assumptions, anonymous musings, and no real metrics," and as a vehicle to communicate the author's "biased views of the industry and clear preference for venture capital investment over protecting the arts."

The industry group argued that lawsuits were essential to allowing labels and artists to claim a share of the revenues from online music consumption. "Finding for Napster would have instantly granted every online service the right to copy and distribute (or at least facilitate such action) without any permission or license, and there would have been absolutely no incentive for Napster to negotiate for them," the RIAA said.

The RIAA also disputed the premise that litigation has diminished venture capital investment, though here it focused more on the 2005 Grokster decision than on the Napster case. "The legal digital music market grew from less than $200 million in 2004 to more than $3 billion in 2011," the association said. "After a unanimous Supreme Court ruling against Grokster, venture capital investment grew for Media and Entertainment to 7.1 percent of total VC dollars from just 4.6 percent before Grokster."

Finally, the industry group argued that some of the stories told in the study are "bogus." For example, Carrier pointed to a PC World article claiming that the major labels had sought $75 trillion in damages against LimeWire, "a figure higher than the Gross Domestic Product of the world." But as Mike Masnick of Techdirt, no friend of the RIAA, pointed out, there doesn't seem to be any credible evidence for the $75 trillion figure. The case was eventually settled for $105 million.

The RIAA has a point in at least one respect: given Carrier's methodology, it's worth taking the study with a large grain of salt. It's not a surprise that entrepreneurs and venture capitalists who locked horns with the recording industry in court a decade ago would be willing to badmouth the industry today. Virtually all the quotes are anonymous, and it's not clear if their claims were independently fact-checked.

Still, the study does point to some serious problems with the recording industry's litigation strategy. The fact that litigation costs have forced startups into bankruptcy after winning in court is a cause for concern. And the uncertainty of the law, along with the threat of statutory damages as high as $150,000 per work, makes it more difficult than it should be for businesses to stand up to industry bullying. The industry's litigation campaign really does seem to have hindered innovation, even if the situation is not as dire as depicted by the RIAA's worst critics.

Update: After this story went live, Carrier sent Ars the following statement:

Yes, they're correct about the Limewire claim. That, as well as the Britney Spears quote about piracy were not correct. Many folks flagged that for me, and I have already taken those points out of the next draft.

Many of the respondents were more than willing to give their names, but I decided it would be better to have all quotes anonymous. To make sure the quotes were accurate, I sent to all 31 the list of quotes I planned to use. 28 said that my quotes were fine as is or offered some minor suggestions to make them more accurate. The final 3 never responded, but the Wisconsin Law Review will be reviewing these to make sure they're all accurate.

The interviewees also included many folks from the labels, who said things very similar to what the innovators said.

Doesn't piracy take away millions of jobs from decent people each year?

Probably world wide, but they probably also count each time a dev company shuffles staff depending on what project they are doing at the time.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

The people that would be best poised to help the industry, to point other people to legal sources, tend to actively dislike the industry because of it's tactics and methods. Not to mention shitty sound engineering and largely asstastic "talent".

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

In the early 90s I wrote a business plan to sell CDs via mail or in kiosks, where customers picked their own tracks. The labels and the Harry Fox Agency were totally against it, saying "no one wants to buy single tracks, everyone wants the full album experience, now get lost."

Doesn't piracy take away millions of jobs from decent people each year?

Probably world wide, but they probably also count each time a dev company shuffles staff depending on what project they are doing at the time.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

In a similar way to how MPAA claims that movie piracy leads to less cinema going, that again leads to less popcorn sales, that again means that corn farmers get less demand for their produce.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

The recording industry != Artists. From the business standpoint, which is the only standpoint they have, they exist to record music artists paying them as little as possible while making as much money as possible. The RIAA's exists solely to screw over artists, the only protection they would ever bother to offer is protection from artists finding new resources that do not include the RIAA.

Doesn't piracy take away millions of jobs from decent people each year?

Probably world wide, but they probably also count each time a dev company shuffles staff depending on what project they are doing at the time.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

That's what I referred to in my comment above. Those studies have been done, but then refuted.

If someone doesn't buy a record, they use that money to buy something else. The idea of a cascading effect is nothing more than fear mongering. I believe the ITC or another government/semi-governmental agency even weighed in on the topic and found exactly that.

You have to understand the labels have two objectives: 1/ Get you to listen to their shit... 2/ completely and utterly control the entire channel from the thoughts in a composer or producers head, all the way to what we consumers listen to, when, where and how.

If the labels thought for a minute there was the slightest chance there was a way to legally mandate that each and every person HAD to listen to a certain amount of music everyday and HAD to pay for it then there would already be laws on the books.

There are signs of this control being asserted all over. Label requirements that DJ's play the entire song beginning to end and not mix one song into another are indicators of this, Payola is another. Music label involvement with big broadcasting entities (clear channel ??? and others) is yet another. Its all about control... With control comes money, with and iron grip on all all aspects of the chain comes obscene amounts of money. Anything that interferes with that chain must be put asunder.

If you want an indication of how far this need for control goes back, then the the book Last night a DJ saved my life is a good read. Its slanted more towards how these things impacted DJs and dance music but it shows that desire to control the medium all the way to back to the earliest days of the phonograph. You might have thought these battles were a somewhat new phenomenon, but no... think mid / late 1800's...

The RIAA is not impressed with Carrier's study, and the organization shared with Ars a draft of a forthcoming response. It characterizes it as "wild speculation based on various assumptions, anonymous musings, and no real metrics," and as a vehicle to communicate the author's "biased views of the industry and clear preference for venture capital investment over protecting the arts."

Err... does anybody has a napkin? I think the RIAA has just bit their tongue so hard there might be some bleeding.

I have NOT reviewed this study in particular, and I think many of uso draw conclusions too quickly from some of the studies, many times misinterpreting positive correlations as causes, or software simulations as undeniable proof, or even not ever questioning methodology and limitations... however it's the same thing with RIAA and IFPI reports. They repeatedly misinterpret data from other sources and fail to report or consider research on shifting markets, consumer preference, global economic aspects, or draw conclusions on very narrow samples of people or countries and try to draw international policy around it. They also seem to keep growing in a year-by-year basis but, since piracy also tends to increase, count that as loss revenue.

Yes, piracy can be a problem. Yes, there should be reasonable efforts to protect copyright and fine offenders. But this institutions keep avoiding honest discussion and insist that governments need to ever increase protections for them and consequences for infringers.

Before the internet the labels had a monopoly. If you made good music and wanted it to be heard, then you had to go through a label.. You couldn't just walk down to your local HMV with a bunch of CDs under your arm.

With the internet labels become less needed. Anyone can make music, put it online and if it is good enough, you can get a return. All without labels taking a cut.

Sure, this model has not taken off yet, but let's face it, artists tend not to be the most tech savvy people. Give it another 10 years.

Before the internet the labels had a monopoly. If you made good music and wanted it to be heard, then you had to go through a label.. You couldn't just walk down to your local HMV with a bunch of CDs under your arm.

With the internet labels become less needed. Anyone can make music, put it online and if it is good enough, you can get a return. All without labels taking a cut.

Sure, this model has not taken off yet, but let's face it, artists tend not to be the most tech savvy people. Give it another 10 years.

Is this the spot where we point out that content owners aren't above sponsoring BS studies either? Like the ones that claim money is removed from the entire economy due to piracy?

EXACTLY !!

RIAA is on their high and mighty horse. Fact of the matter is that big labels are the disease in the recording industry. And I know a thing or two about this as I have to deal with these suits aka @ss holes on a daily basis.

Before the internet the labels had a monopoly. If you made good music and wanted it to be heard, then you had to go through a label.. You couldn't just walk down to your local HMV with a bunch of CDs under your arm.

With the internet labels become less needed. Anyone can make music, put it online and if it is good enough, you can get a return. All without labels taking a cut.

Sure, this model has not taken off yet, but let's face it, artists tend not to be the most tech savvy people. Give it another 10 years.

Social custom says that I should include the terms "draconian, DRM, pirates, price inflation, wage inflation, loss of jobs, innovation, [insert essence here]-sucking" somewhere in my comment here as well, but alas I don't have the time.

Doesn't make sense to attack RIAA. They and the labels they represent are all about selling CDs (and before that, vinyls). We need a new breed of music publishers who can take the premier music talent of our times and directly channel all this talent via the Internet for our listening pleasure (and dollars).

Doesn't make sense to attack RIAA. They and the labels they represent are all about selling CDs (and before that, vinyls). We need a new breed of music publishers who can take the premier music talent of our times and directly channel all this talent via the Internet for our listening pleasure (and dollars).

Except the story basically says that one of the primary motivators for this mess is retailers like Wal-mart and Tower records.

The people that would be best poised to help the industry, to point other people to legal sources, tend to actively dislike the industry because of it's tactics and methods. Not to mention shitty sound engineering and largely asstastic "talent".

That's not true at all. Our own Executive branch is more or less lined up around the block the fellate the RIAA and MPAA at every opportunity. They've been very helpful to the industry.

Doesn't piracy take away millions of jobs from decent people each year?

Probably world wide, but they probably also count each time a dev company shuffles staff depending on what project they are doing at the time.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

That's what I referred to in my comment above. Those studies have been done, but then refuted.

If someone doesn't buy a record, they use that money to buy something else. The idea of a cascading effect is nothing more than fear mongering. I believe the ITC or another government/semi-governmental agency even weighed in on the topic and found exactly that.

The RIAA is not impressed with Carrier's study, and the organization shared with Ars a draft of a forthcoming response. It characterizes it as "wild speculation based on various assumptions, anonymous musings, and no real metrics," and as a vehicle to communicate the author's "biased views of the industry and clear preference for venture capital investment over protecting the arts."

Err... does anybody has a napkin? I think the RIAA has just bit their tongue so hard there might be some bleeding.

I have NOT reviewed this study in particular, and I think many of uso draw conclusions too quickly from some of the studies, many times misinterpreting positive correlations as causes, or software simulations as undeniable proof, or even not ever questioning methodology and limitations... however it's the same thing with RIAA and IFPI reports. They repeatedly misinterpret data from other sources and fail to report or consider research on shifting markets, consumer preference, global economic aspects, or draw conclusions on very narrow samples of people or countries and try to draw international policy around it. They also seem to keep growing in a year-by-year basis but, since piracy also tends to increase, count that as loss revenue.

Yes, piracy can be a problem. Yes, there should be reasonable efforts to protect copyright and fine offenders. But this institutions keep avoiding honest discussion and insist that governments need to ever increase protections for them and consequences for infringers.

I have never seen any evidence outside of industry-funded propaganda studies that suggests piracy has caused any problems at all. I have seen plenty of evidence that piracy has a net positive effect.

Doesn't make sense to attack RIAA. They and the labels they represent are all about selling CDs (and before that, vinyls). We need a new breed of music publishers who can take the premier music talent of our times and directly channel all this talent via the Internet for our listening pleasure (and dollars).

Google is working on it. When they announce the music section of their Play store they also announced a system for individuals and groups to register music directly for sale there.

I'm pretty sure it's in North America only. Like the dry cleaner down the street closed and he used to clean suits for a guy who worked for a delivery service who worked for the RIAA. The dry cleaner closed down due to piracy. It's all Napster's fault.

Where's Kevin Bacon in all that?

We may have defeated the six degrees.

Nope, he was the delivery guy. He couldn't get work after the Pirate Bay killed Hollywood.

If you want an indication of how far this need for control goes back, then the the book Last night a DJ saved my life is a good read. Its slanted more towards how these things impacted DJs and dance music but it shows that desire to control the medium all the way to back to the earliest days of the phonograph. You might have thought these battles were a somewhat new phenomenon, but no... think mid / late 1800's...

The book Free Culture is a variation on that from the perspective of society. And it's free.

Timothy B. Lee / Timothy covers tech policy for Ars, with a particular focus on patent and copyright law, privacy, free speech, and open government. His writing has appeared in Slate, Reason, Wired, and the New York Times.